IFAC SEMINAR THE FINANCIAL REPORTING ENVIRONMENT IN THE 21 ST CENTURY. The State of Financial Reporting in the Public Sector

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1 IFAC SEMINAR THE FINANCIAL REPORTING ENVIRONMENT IN THE 21 ST CENTURY The State of Financial Reporting in the Public Sector Remarks by Fayezul Choudhury, Vice President and Controller Thank you to Mike for a very insightful and instructive presentation. I have been asked to share some observations about governmental financial reporting, drawing on my experiences as the Vice President and Controller of the World Bank. I very much welcome the opportunity to do this, and I thought it might be useful for me to organize my remarks around the themes that Mike has elaborated. First.. Public sector context and importance there is much to be done! The World Bank lends money to governments for general budget support, and to finance specific investment projects aimed at generating outcomes that will reduce poverty. In the 2007 fiscal year, we committed almost $25 billion for this purpose. And the Bank is required, under its Articles of Agreement, to make arrangements to ensure that loan proceeds are used only for the purpose for which the loan was granted. So at the Bank we have a particular interest in governmental financial reporting, as the primary means of providing assurance that loans are being used for their proper purposes. We believe that the best assurance that the Bank can obtain on the use of its funds is when it provides them to countries whose institutions have good financial management arrangements. And we are actively supporting public financial management reform programs in all areas of the developing world. But I would have to agree with Mike that, whilst incremental gains are being made, there remains considerable room for improvement.

2 Specifically, the quality of governmental financial reporting is generally not good. Financial statements are frequently incomplete they do not report on all the resources and obligations of the reporting entity. Revenue and expenditures are kept off-budget. The boundaries of the reporting entity are unclear. Cash receipts and payments are reported, rather than revenues and expenses. Voluminous reports in excessive detail are provided, rather than succinct and meaningful financial information. And reporting is not timely. In the 2007 fiscal year, 60% of the audited financial statements for Bank-financed operations were received late (i.e., more than 6 months after the end of the reporting period). And one quarter of all audit opinions were qualified. So yes, there is much room for improvement. Even incremental steps like clarifying the components of the reporting entity could yield disproportionate benefits. In the past, the Bank s usual approach to accounting and reporting for Bank-financed projects was to seek to ring-fence the project financial management system in a standalone entity, reporting to but separate from the relevant government agency. The theory was that this would safeguard the project funds for the purposes of the operation, and avoid their being lost in the government s accounting system. In recent years, our thinking has evolved on this issue. Project-specific entities do little to build lasting capacity, can divert scarce resources away from enduring government institutions, and have often created perverse incentives for public officials. Accordingly, the Bank now envisions borrowers own entity accounting and reporting systems as being the default option where feasible for embedding the financial management aspects of Bank-financed operations. This shift in thinking has meant that we now focus to a far greater extent on the overall quality of governmental financial management in our client countries, and how we can help with building the necessary capacity to undertake more ambitious financial management reforms which brings me to Mike s second point:

3 The importance of accrual accounting especially with respect to accountability and stewardship From the Bank s perspective, the case for accrual accounting is unarguable. Of course governments should account for and report on all assets and liabilities, and all revenues and expenses. Many of the shortcomings we see in governmental financial statements stem from the lack of a coherent framework for recording and reporting on all resources and obligations. And whilst the context for financial reporting in the public sector differs from the private sector, there are no compelling reasons for the basics of accounting and recording transactions to be different between the sectors. That said, we recognize that the adoption of accrual accounting should not be an end in itself. Rather, it should be seen as one component of a broader program of public financial management reform without this context, there is a risk that it becomes a largely academic exercise. As Mike has noted, accrual accounting is critical for stewardship and accountability purposes. And clearly the Bank is especially interested in this aspect of reporting, given our need to report to stakeholders on the use of loan proceeds. But we are also concerned with the broader development goals of our partner countries. In this context, accrual accounting is not only about reporting on the stewardship of public resources. It is also about better management. The systems and structures necessary to report relevant and reliable financial information to stakeholders will also foster strong financial management practices within organizations, and better decision-making. This in turn will build stronger public financial management institutions, and contribute towards broader development goals. However, we do need to be realistic about the capacity constraints that many of our client countries are grappling with. Qualified accountants are in very short supply in many of the environments we operate in, and working for the government is not everyone s first career choice. Moreover, given the range of development challenges that many of our

4 clients face, difficult tradeoffs need to be made. And whilst I m sure that everyone here would agree with me that better accounting should be near the top of the list, a counterargument would be for building schools and investing in clean drinking water. One of the factors underpinning the very slow progress of improvement in governmental financial reporting in both the developing and the developed world has been the lack of a generally-accepted body of standards. We have heard from Mike about the excellent progress that the IPSASB has been making towards establishing a stable platform of IPSASs, and I would like to close by making a few observations: an overview of the state of adoption/implementation of IPSASs First, on the current state of adoption of IPSAS the progress has been outstanding, and the results of the research project point to widespread adoption, and the cementing of the IPSASB s role as the pre-eminent financial reporting standard-setter for government. The extent of this progress is all the more noteworthy, given the period over which it has been achieved. The Bank first became involved with IFAC s Public Sector Committee in the mid-1990s, and I can clearly recall the chorus of disapproval some of it from within the Bank, I might add at the notion that the accounting profession might have an important contribution to make to the debate on financial reporting by governments. To have come so far in barely a decade is remarkable. IPSASB's initiatives Second, regarding IFAC s initiatives this is clearly a very ambitious program, to be delivered over a tight timeframe. At the Bank, we are particularly keen to see several of these projects brought to fruition: The implementation review of the Cash Basis IPSAS recognizing that many governments still report on some form of cash accounting, the Cash

5 IPSAS remains a flagship standard, and a review of users experience with it is now due. The conceptual framework like many standard-setters, the IPSASB wisely chose to get some runs on the Board in terms of issuing standards before figuring out what the underlying concepts might be. You can get away with this only for a limited period, which I suspect may now have elapsed so this is very timely. Management Discussion and Analysis the narrative and analysis that accompanies financial statements is of critical importance in the public sector, given the stewardship and accountability aspects of governmental financial reporting. So we see this piece of work as being particularly significant. I could carry on listing these projects for some time as they are all important but I won t. The three I have mentioned particularly interest us at the Bank, but it s fair to say that if all these initiatives are completed on time, the IPSASB can well and truly claim to have brought governmental financial reporting into the 21 st Century. our future plans And in closing, let me say how much I welcome and echo Mike s sentiments that leadership comes from strong partnerships. At the Bank we have enjoyed working with the IPSASB over the past decade, we feel that we have made considerable progress together, and we look forward to continuing this very fruitful partnership.